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    Question

    A company has Rs.500,000 of debt outstanding with a coupon rate of 10%. The yield to maturity on these bonds is 15%. If the rate of tax is 40%, what is the company’s after-tax cost of debt?

    A 9% Correct Answer Incorrect Answer
    B 6% Correct Answer Incorrect Answer
    C 10% Correct Answer Incorrect Answer
    D 15% Correct Answer Incorrect Answer
    E None of the above Correct Answer Incorrect Answer

    Solution

    In case of a redeemable long term debt, the cost of debt is the investor’s yield to maturity adjusted by the firm’s tax rate. The question of yield to maturity arises only when the loan is taken either at discount or at premium. As such, the YTM is considered as cost of debt here and not the coupon rate. Therefore, the after-tax cost is:   15% * (1- 40%) = 0.09 ~ 9%

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